In the wake of the post-2008 real estate recovery, many homeowners are discovering that they now have equity, where they had been “underwater” for several years prior.
The happy current situation has enabled many homeowners to drop their monthly payments by refinancing to a lower interest rate.
But what about those whose credit histories bear the scars of the Great Recession? Are they out of luck? It seems that every newspaper and magazine article insists that banks are “cherry picking” the very best borrowers, those with flawless credit histories, and discarding those mere mortals whose credit reports have late payments and other derogatory information.
These articles are, for the most part, completely false. Current standards for conventional loans call for a FICO score of 620 or higher. While it is true that a borrower with a 620 score will pay a higher rate than one with a 740 score, both borrowers are within the guidelines for conventional loans.
What does a 620 FICO score look like? Every case is different, but a borrower could have several 30 and 60 day late payments, high credit card balances and possibly a collection account or two. That imperfect individual can still be approved for a mortgage.
The first piece of advice we offer is to remove any doubt about your credit score before applying. Go to a site like creditkarma.com or freecreditreport.com to get an idea of what your credit report looks like. This will not cost you anything, and it will give you some insight into where you are now. Accessing your own credit file does not affect your FICO score in any way.
If your score really is too low
There are two reasons why raising your credit score is a good idea. First, if your score is below 620, you need to raise it in order to get a conventional mortgage. Second, if your score is above 620 but below 740, you will be able to reduce the cost of your new loan with a higher score. If your score is 620, your 30-year loan will carry a rate of around 4.375%. The same loan for a borrower with a 740 score will be at 3.75%.
Raising your score quickly
There are “credit repair clinics” in business today who promise to add hundreds of points to your credit score. They all operate under the same principle: they dispute every item of negative information in the credit report whether it is true or not. If the creditor doesn’t respond within 30 days, the entry has to be removed—but it can reappear if it was valid in the first place.
Check for errors
You should check your credit report carefully to find anything that might be inaccurate. Are there accounts that you don’t recognize? You may be the victim of identity theft. Contact the credit bureau to get it corrected. Are there collection accounts and judgments that you have paid, but which are still showing as being open? These are accounts you definitely should dispute. You can do this online by going to each of the three credit bureaus.
Ask creditors for help…really!
If there are occasional late payments to department stores, call their credit office to ask them to remove the late payment. After all, you are a very good customer, and that late payment was just a momentary oversight. You might be pleasantly surprised at how often retailers are eager to help their customers by removing late payments.
Finally, look at your credit card balances. Once the balance on a credit card exceeds 30% of the credit limit (the credit utilization rate), your score starts to go down. You can get an immediate score boost by paying down your balance—or you can often accomplish the same thing by asking the credit card company for a credit line increase.
If you have a $2,500 balance on a card with a $5,000 limit, your credit utilization is 50%. That will lower your score by as much as 20 points. If the credit report company agrees to raise your limit to $8,500, you drop below that 30% threshold—without taking any cash out of your pocket.
With that said, however, keep in mind that carrying a balance on most credit cards is very expensive; rates often exceed 30%, so carrying a $2,500 balance would cost you $62.50 per month interest. This is not the best way to spend your money.
We should dispel some more myths here:
- Inquiries from prospective creditors don’t ruin your score. Credit inquiries make up just 15% of the FICO score. A “hard” inquiry, as from a mortgage company, will initially have little or no effect on your credit score. Multiple inquiries made for the same purpose within a 45-day time span are considered one inquiry. These “shopping inquiries” will have little or no effect on your score. On the other hand, opening up three or four new credit card accounts over a three-month period WILL affect your score—possibly by a lot.
- Paying off a collection account or one with past due payments won’t make the derogatory entry go away; the history will remain. An “active collection” account’s status will change to “paid collection” once you have paid it. Depending on how old the account is, it may or may not improve your score.
- Putting a “consumer statement” in your credit file will have no effect on your score. It is your right to record the statement, but the primary result will be that you may feel a little better about yourself after doing it.
Now is a good time to get a new mortgage—despite what the media would have you believe. Don’t simply assume that you won’t qualify because of your credit score; find out where you stand now, then take the appropriate steps to accomplish your goal.